The Barber of Buenos Aires cuts again

Argentina is going to get a large haircut on its debt. That was a foregone conclusion. Now, though, Covid-19 has worsened the situation. Yet for some reason Argentina has made a very generous opening offer, about what I would have expected in a world without a pandemic. I don’t know why.

The country could not have paid before Covid-19 hit; it certainly can’t pay now. So President Fernández’s finance minister, Martín Guzmán, proposed a debt restructuring that was far more generous than most economists expected.

Of course, restructuring the debt is ultimately a political decision, and economists still aren’t too good at predicting political decisions. That said, economists do think the offer is pretty generous towards creditors.

First, how generous? I came up with a back-of-the-envelope calculation for at least a chunk of the outstanding private debt. We know the following:

• The face value of that debt is going to cut from $67 billion to $63 billion, or 5.4%;
• The total interest that will be paid on that debt before its retired (or rolled over) is going to be cut from $61 billion to $23 billion;
• Coupon payments will be suspended for three years, after which they will rise slowly from 0.5% in 2023 to a maximum of 4.5%.

If you assume that the coupon rate will rise by 0.5 percentage points per year, then it is possible to estimate a flow of payments and discount that back to year zero. You can do that for the original flow of payments and the restructured flow in order to estimate the “haircut” on the debt. Of course, in order to do that you need a discount rate. What to use? You could use the current yield on Argentine debt, which is in the vicinity of 40%, but that number reflects the fact that everyone knows that the country can’t possibly repay its current debt load. You could use the rate at which most of the debt was issued at, around 7%, but that reflects the optimism of the Macri years and does not reflect the country’s likely post-restructuring situation.  

At 40%, the haircut comes to 90%! That can’t be right. At 6.7%, the haircut comes to 49%, but that waves away the fact that Argentina is riskier now. There is a lot of chatter for a 12% rate, which sounds right. Using that, you get a haircut of 60%. Which is still less than Argentina got back in 2005.

Why be so generous?

Comments

[F]

Noel -- how do you think what the "right" or "fair" number is? I.e., why is 60% haircut too generous to creditors?

[Noel Maurer]

That's an excellent question!

It's not a matter of fairness. Rather, it's about sustainability and negotiation.

Argentina is a low-savings country dependent on primary product exports. Argentina is about to issue a massive amount of internal debt in order to finance Covid relief; the more fiscal space it has, the better. And who knows if the place will grow the way that it did after 2005? The smaller the debt, the more sustainable.

But my main point is about negotiation. First offers are usually rejected. Why then start with a relatively low number? There may be a strategy there, but it's not clear to me.

[F]

Thanks for your thoughts! I suspect that Argentina can indeed service their offer (and likely something even more) but to stick to your point on negotiation -- I actually found their offer almost spot on in terms of negotiation strategy. In a sovereign restructuring with a cohesive group of creditors the sovereign should know that they have to give creditors at least a little bit above the market price. The market price is essentially saying: "This is our BATNA. We can get this even if you play hardball". Naturally that isn't always the case (and market volatility, etc) but that's what the strategy appears to be